Brexit FAQs

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ISDA Brexit FAQs

These FAQs address the possible UK position post-Brexit, i.e. after the conclusion of the exit process under Article 50 of the Lisbon Treaty. There is still considerable uncertainty as to the form of the UK’s relationship with the European Union after the conclusion of the exit negotiations, including as to whether the proposed transitional period until 31 December 2020 (as set out in the draft Agreement on the withdrawal of the UK from the EU and European Atomic Energy Community dated 19 March 2018 (the “the “Draft Withdrawal Agreement”)), during which passporting rights of UK and EU firms, respectively, would be maintained, will in fact come into force. Consequently, the responses to these FAQs involve an assessment of the various outcomes of the exit negotiations and the consequences of those outcomes and it is not possible in all cases to give a definitive answer. We have divided the FAQs into ‘The short read’ and ‘The long read’, with the former being a summary of the latter and the latter only available to ISDA members.

Market participants should take independent legal advice on the points addressed in these April 2018 FAQs.

On November 20, 2017, ISDA hosted an update Webinar on Brexit. To listen to the webinar, click here.

Disclaimer: This page does not contain legal advice and merely is intended as an information resource to assist market participants in planning for the exit of the UK from the EU following the official notification on March 29, 2017 of the UK’s intention to withdraw from the EU, the confirmation from the European Council on 15 December 2017 that sufficient progress had been made to move to the second phase of negotiations (relating to (i) transition, and (ii) the framework for the future relationship between the UK and the EU), and publication of the Draft Withdrawal Agreement.

Note that the Draft Withdrawal Agreement is a political document and not legally binding. Unless stated otherwise, reference to a position taken in the Draft Withdrawal Agreement should be assumed to be agreed at negotiators’ level between the UK and the EU27.

Contractual points under ISDA Documentation

  1. Could Brexit constitute a Force Majeure, Impossibility or an Illegality Termination Event under the ISDA Master Agreement? 

The Force Majeure Termination Event in the ISDA 2002 Master Agreement requires an actual impediment to making or receiving payments or deliveries or from complying with any other material provision of the Agreement as a result of an act of state beyond the control of the relevant party. The Impossibility Termination Event (as set out as an optional additional clause in the ISDA 1992 Master Agreement User Guide) requires a similar impediment to performance as a result of, inter alia, an act beyond a party’s control.

The triggering of Article 50 and the conclusion of the exit negotiations will probably constitute an act of state for the purpose of the ISDA 2002 Master Agreement and an act beyond the control of the party/ies for the purpose of the 1992 ISDA Master Agreement, being acts carried out by the UK government over which the parties have no control. However, the requirement for an impediment to performance as a result of such act of state is likely to be missing in most cases.

The Illegality Termination Event is triggered by performance of an obligation becoming illegal under an applicable law. The loss of EU passporting rights when the UK leaves the EU might lead to a UK party to a Transaction being unable to enter into derivative transactions with an EU based counterparty, (or even a non-UK party being unable to enter into derivative transactions with a UK based counterparty if the overseas person exemption is withdrawn post-Brexit; see Question 16.1 (EU firms’ ability to carry out derivatives business in the UK)), but merely performing pre-existing contractual obligations under Transactions entered into pre-Brexit generally ought not to be subject to local authorisation requirements. Currently, entering into derivative transactions with counterparties in the EU can be carried out pursuant to MiFID II[1] and UK/EU parties exercise their “passporting rights” pursuant thereto to provide investment services which are covered by that Directive. Performing an existing transaction would not seem to fall within MiFID II as it does not involve the provision of an investment service or ancillary activity which is covered by MiFID II. Specifically, it does not involve the reception or transmission of orders, the execution of orders or dealing on own account. For performance of an existing transaction to be subject to authorisation, therefore, (i) the local jurisdiction would have to have implemented MiFID II in a way which goes beyond the requirements of MiFID II, (ii) there would have to be a change in law at European or local law level or (iii) the local regulator would need to take a particularly restrictive view as to what activity non-authorised entities are permitted to carry out in their jurisdiction. This will ultimately depend on the position under local law and regulation.

Also, certain events during the life of a transaction may involve more than the mere performance of existing contractual obligations. If such an event could be construed as entry into a new derivative transaction that is subject to either MiFID II passporting or authorisation in the relevant EU member state, then loss of the passport could render such activity illegal in the EU. This will depend on whether the event involves the provision of an investment service (essentially a dealing type activity that in effect involves entering into a new trade in a “financial instrument”), although in at least some member states, engaging in these activities on a reverse-solicitation basis (that is, where the counterparty has solicited the business of the UK firm, rather than the UK firm soliciting business in the jurisdiction) may fall outside the scope of the regulatory regime while in other jurisdictions other exemptions may be available. This issue may be more relevant for certain product types, for example swaptions (where exercise of the swaption results in a new derivative transaction arising). The outcome would need to be assessed on a jurisdiction by jurisdiction basis in light of the total loss of passporting rights, assuming the absence of an equivalence decision or individually negotiated position retaining access for UK financial service firms to EU financial markets. ISDA has obtained high level, summary advice from counsel in France, Germany, Italy, the Netherlands and Spain, as well as the UK, as to the expected regulatory treatment (under current law and regulation) of certain lifecycle and other events, which is available here. For more on this point, see Question 16 (Access to the EU financial markets).

Brexit may therefore impact upon the ability to enter into new Transactions or to modify, or otherwise undertake a dealing type activity in relation to, existing Transactions where this constitutes provision of an investment service but it is unlikely in most cases (although there is a risk that certain EU regulators may determine otherwise) that the performance of existing Transactions would become illegal and so trigger the Illegality Termination Event.

As far as EU firms conducting activities in the UK after exit is concerned, the UK Government has announced[2] that, alongside the “temporary permissions” regime (see Question 16 (Access to the EU financial markets)) it will legislate if necessary to ensure that contractual obligations which are not covered by the regime can continue to be met.  This could possibly be used to create greater certainty that EU firms can continue to perform obligations under existing derivatives contracts with UK counterparties after the UK leaves the EU.

2.  Could Brexit constitute a Tax Event Termination Event under the ISDA Master Agreement?

Broadly speaking, a Tax Event occurs when one party is required to make an additional payment, or the other party is required to receive a payment subject to a deduction, in respect of tax deducted or withheld from a payment as a result of, inter alia, a change in tax law (as defined in the ISDA Master Agreement) after the parties have entered into the Transaction.

Certain EU directives govern the imposition of withholding tax on payments between entities in the EU, for example the Interest and Royalties Directive exempts from withholding tax interest payments between associated entities within the EU. These directives have already been implemented into UK law via primary legislation. Consequently, it is expected that (at least initially) there would be no change to the UK withholding tax consequences of transactions within the scope of these directives as a result of Brexit. However, depending on the relevant local law and the outcome of the exit negotiations, the withholding tax consequences of transactions within the scope of these directives in other EU member states may change, because Brexit may result in the UK becoming a third country from the perspective of that other EU member state. Note, however, that because they only apply to payments between associated entities (and will in any case only be relevant where there would be withholding under the applicable domestic law), these directives are only likely to be relevant to a limited category of Transactions.

Following Brexit, there may be domestic law change in the UK and elsewhere, or the way in which existing domestic law applies may change, which could result in additional withholding tax on payments made in cross-border transactions. For example, the UK could use the opportunity to impose new withholding taxes, or a domestic law exemption from withholding tax in another jurisdiction may cease to apply to UK entities (by virtue of the fact that the UK has ceased to be an EU member state). The occurrence of a Tax Event in these circumstances will depend on the change in law or application in question (which in turn may depend on the outcome of the exit negotiations), and whether withholding tax would affect payments made on the underlying Transactions. 

  1. Could there be a breach of the representation under Section 3(a)(iii) (No violation or Conflict) or Section 3(a)(iv) (Consents) of the ISDA Master Agreement as a consequence of Brexit?
  • Section 3(a)(iii), the ‘no conflict with applicable law’ representation, includes a representation that performance does not conflict with any law applicable to the relevant party. Post-Brexit this representation should continue to hold true under English law, but in respect of non-UK entities entering into Transactions on a cross-border basis with entities in the UK, this may depend on the continued availability of the overseas person exemption, or the availability of a transitional period agreed between the UK and EU (such as that proposed under the Draft Withdrawal Agreement), or temporary permissions for EU firms in the UK after exit (see Question 16.1 (EU firms’ ability to carry out derivatives business in the UK)). UK entities transacting with EU counterparties on a cross-border basis, are not expected to retain their passporting rights in respect of investment services, on the UK exiting the single market (subject to any transitional period as previously mentioned).  If, as a result of the loss of passporting rights, the continued performance of obligations under Transactions requires authorisation in the EU member state where the counterparty is located, there is a risk that such performance could be considered to be in contravention of the laws of such EU member state. This outcome is unlikely in most cases as merely performing pre-existing contractual obligations under derivative Transactions entered into pre-Brexit generally ought not to be subject to local authorisation requirements. However, this will depend on local law and regulation in the place of performance (please refer to the answer to Question 1 (Force majeure, Impossibility or Illegality Termination Event)). As noted in the response to Question 1 (Force Majeure, Impossibility or Illegality Termination Event), this position is further complicated by the implications of any modification or novation of, or other dealing type activity in relation to, such pre-Brexit Transaction which may be construed locally as the entry into of a new Transaction which is subject to authorisation in that member state. This issue may be more relevant for certain product types, for example swaptions (where exercise of the swaption results in a new derivative transaction arising). The outcome would need to be assessed on a jurisdiction by jurisdiction basis in light of the position of UK financial services firms when the UK completes the exit process. ISDA has obtained high level, summary advice from counsel in France, Germany, Italy, the Netherlands and Spain, as well as the UK, as to the expected regulatory treatment (under current law and regulation) of certain lifecycle and other events, which is available here.

For more on this point, see Question 16 (Access to the EU financial markets).

Notwithstanding this, assuming that this representation is true and accurate when given and repeated pre-Brexit (including on entering into each new Transaction), then existing Transactions will not cause a Misrepresentation Event of Default simply by virtue of such representations becoming untrue at a subsequent date as a result of Brexit. In respect of new Transactions entered into post-Brexit, including the novation or modification of, or other dealing type activity in relation to, any existing Transaction which could be construed as entry into a new Transaction, in the absence of passporting rights, or, in respect of non-UK entities transacting with UK entities on a cross-border basis, if any transitional period agreed between the UK and EU (such as that proposed in the Draft Withdrawal Agreement), or temporary permissions for EU firms in the UK after exit (see Question 16.1 (EU firms’ ability to carry out derivatives business in the UK)) have expired and the overseas persons exemption is removed, there could be a breach of this representation. For more on this point, see Question 16 (Access to the EU financial markets).

Section 3(a)(iv), the representation on consents, is subject to similar considerations if passporting rights are not retained. For more on this point, see Question 16 (Access to the EU financial markets).

  1. Could there be a Breach of Agreement under Section 5(a)(ii) in respect of the obligations in Section 4(b) (Maintain authorisations) or Section 4(c) (Comply with Laws) of the ISDA Master Agreement as a consequence of Brexit?

 

Pursuant to the first limb of Section 4(b) parties agree to use all reasonable efforts to maintain the consents required to be obtained with respect to the Agreement. This could present an issue following the expected loss of passporting rights on Brexit. From a UK perspective, the parties will have the same authorisation as before, but no passporting rights. If passporting rights were required for a UK entity to continue performance of its obligations under the existing Transactions with an EU counterparty, then the UK entity would no longer have the consents required with respect to the Agreement. As set out in the answer to Question 1 (Force majeure, Impossibility or Illegality Termination Event), merely performing pre-existing contractual obligations under derivative Transactions entered into pre-Brexit generally ought not to be subject to local authorisation requirements, although there is a risk that certain EU regulators may determine otherwise. The position could be complicated by any modification of the terms of such Transactions post-Brexit, or any other dealing type activity or novation, that is construed locally as entering into a new derivative Transaction. ISDA has obtained high level, summary advice from counsel in France, Germany, Italy, the Netherlands and Spain, as well as the UK, as to the expected regulatory treatment (under current law and regulation) of certain lifecycle and other events, which is available here.

For more on this point, see Question 16 (Access to the EU financial markets).

The second limb of Section 4(b) provides that parties will use all reasonable efforts to obtain any consents that may become necessary in the future. The question arises as to whether this imposes an obligation on a UK entity to seek authorisation in the relevant EU member state in order to perform the Transaction (if such is required), or on a non-UK entity to seek authorisation for cross-border Transactions in the UK, if this becomes necessary. This seems unlikely in most cases. However, if there were an obligation to seek authorisation, the Illegality Termination Event would probably be available to the party that had lost its passporting rights, although this depends on whether the relevant law is an “applicable law” for the purposes of the Illegality Termination Event, which, under the 1992 ISDA Master Agreement, is not clear.  If the Illegality Termination Event is available, it would, in accordance with the hierarchy provisions in Section 5(c), prevail over any possible Breach of Agreement Event of Default.

For there to be a breach of Section 4(c), compliance with all applicable laws, the party would have to fail to comply with any applicable law to which it is subject and such failure must materially impair its ability to perform its obligations under the Agreement or any Credit Support Document. The loss of passporting rights would only be a breach of Section 4(c) if, in the absence of an immediate equivalence determination, this makes it illegal for the UK party to perform the Transaction. In respect of a non-UK entity which has entered into Transactions with a UK entity, there would only be a breach of Section 4(c) if the UK amended its laws to make it illegal for the non-UK party to perform the Transaction.

In these circumstances, the Illegality Termination Event would probably be available to the UK party, although as noted above this depends on whether the relevant law is an “applicable law”. If the Illegality Termination Event is available, it would, in accordance with the hierarchy provisions in Section 5(c), prevail over any possible Breach of Agreement Event of Default.

  1. Could Brexit trigger an event of default or termination event under the ISDA/FIA Client Cleared OTC Derivatives Addendum?

The Cleared Transaction Illegality/Impossibility event under the ISDA/FIA Client Cleared OTC Derivatives Addendum (the “Addendum”) (if applied by the parties) provides for termination if it becomes unlawful under any applicable law or impossible or impracticable for either party to make payment or delivery with respect to the Client Transaction or to comply with any other material provision of the Agreement. In the event of Brexit resulting in a loss of passporting rights with no negotiated access to the EU financial markets for UK banks/investment firms and no equivalence decision for the UK as a third country under MiFID II (as to which, see Question 16 (Access to the EU financial markets)), it is unlikely in most instances that the continued performance of Transactions would be subject to authorisation requirements in EU member states with payment or delivery thereunder consequently rendered ‘unlawful’ (see Question 1 (Force majeure, Impossibility or Illegality Termination Event)), although there is a risk that certain EU regulators may determine otherwise and this would depend upon local law and regulation. This would seem to be more relevant than performance being seen to be ‘impossible’ or ‘impracticable’ in these circumstances.

If, however, there is a novation or a modification of, or other dealing type activity in relation to, the Transaction that in effect involves entering into a new trade in a “financial instrument”, entry into such new trade may be subject to authorisation requirements in the relevant EU member state. This issue may be more relevant for certain product types, for example swaptions (where exercise of the swaption results in a new derivative transaction arising). In such circumstances, the loss of any related passport in the absence of an immediate equivalence determination could render the entry into of such new trade illegal in that EU member state, although this will depend on the relevant local law and regulation.

The occurrence of any illegality in respect of existing payment or delivery obligations or any other material provisions of the Agreement would need to be determined on the basis of the eventual position of UK financial institutions after conclusion of the UK exit negotiations (and after the application of any transitional period, such as that proposed in the Draft Withdrawal Agreement) and by reference to the relevant EU member state’s regulatory regime applicable to the continued performance of the terms of the Transaction.

An event that is an Event of Default or Termination Event under the ISDA Master Agreement in respect of the party which is the Client under the Addendum will apply in respect of the Client Transactions under the Addendum, but only for the benefit of the Clearing Member (since Section 8(b)(1) of the Addendum disapplies such events for the benefit of the Client). Please see Question 1 (Force Majeure, Impossibility or Illegality Termination Event), Question 2 (Tax Event), Question 3 (Breach of representation) and Question 4 (Breach of Agreement) for potential Events of Default/Termination Events under the ISDA Master Agreement.

A CM Trigger Event may also occur if the loss of passporting rights causes the party which is the Clearing Member to be in default under the rules of an EU CCP and that EU CCP formally declares such Clearing Member to be in default of its rules, triggering its default management process (or such process is triggered automatically as a result of such a loss of passporting rights by the Clearing Member). An analysis of the rules of each relevant CCP would be required to determine whether such an event might be triggered.

A CCP Default may also occur if a UK CCP loses its rights to offer clearing services pursuant to EMIR, is not granted recognition pursuant to the third country provisions in Article 25 of EMIR (as to which see Question 19 (Clearing pursuant to EMIR by a UK CCP)) and the rules of that CCP entitle Clearing Members to terminate their transactions with that CCP (or such termination takes place automatically) as a result. An analysis of the rules of each such UK CCP would be required to establish whether such an event might be triggered.

  1. Could Brexit trigger any other provisions in the ISDA Master Agreement/Credit Support Documents?

Parties may have included a ratings downgrade provision as an Additional Termination Event/additional Event of Default which may be triggered if the market impact of Brexit is such as to result in ratings downgrades of counterparties.

Depending on the description of eligible collateral in any Credit Support Annex/Credit Support Deed, the downgrading of the UK government may result in UK debt becoming ineligible as credit support.

The market impact may also affect the mark-to-market value, particularly cross-currency swaps involving sterling, which may lead to increased margin calls.

Bespoke Additional Termination Events/Events of Default included in ISDA Schedules to address the outcome of the UK referendum/Brexit may also be triggered.

  1. Does Brexit impact any of the provisions of the ISDA Definitions booklets?

The eventual market impact may result in additional Credit Events pursuant to the 2014 Credit Derivatives Definitions. Adverse consequences for the financial markets may also result in the occurrence of one or more of the Additional Disruption Events pursuant to the 2002/2011 Equity Derivatives Definitions.

  1. Should parties consider including any additional termination rights based on Brexit? 

One of the key risks for derivative markets is the expected loss of passporting rights pursuant to the various EU financial services directives and the absence of any immediate equivalence decision to replace such lost rights. This may not necessarily impact existing cross-border Transactions as their continued performance may still be permissible even post-Brexit. Were their continued performance to become subject to local authorisation, then, in the absence of local authorisation, performance will not be possible.

In these circumstances it is likely that parties would be able to rely on the Illegality Termination Event. There is a question under the 1992 ISDA Master Agreement as to whether the local law in the place of performance constitutes an “applicable law” for the purposes of the Illegality Termination Event (the same point does not arise on the ISDA 2002 Master Agreement). In order to remove any uncertainty, one possible option for parties to a 1992 ISDA Master Agreement is to include an Additional Termination Event addressing the circumstances of the inability of a UK entity to continue performance of an existing Transaction due to the loss of passporting rights and the existence of local law requirements preventing performance.  Non-UK entities might consider including this termination right as well in the circumstances of an amendment to UK law which renders continued performance of Transactions illegal. In addition, if it becomes illegal to exercise a right under a Transaction, this will not be an Illegality but it may justify an early termination, in which case an Additional Termination Event will be required to address this.

Another risk would be the inability to clear derivative Transactions through EU CCPs (in the case of UK entities) or UK CCPs (in the case of EU entities) or the inability to report Transactions to UK/EU trade repositories if there is no EMIR authorisation by the EU in respect of UK CCPs/trade repositories and vice versa (please see Question 19 (EMIR clearing/reporting by UK CCPs/trade repositories) and Question 20 (EMIR clearing/reporting by EU CCPs/trade repositories)). Even in the absence of reciprocal recognition, it is not certain that this would have an effect on existing trades. An option is to include additional termination rights to address these eventualities.

Choice of law, jurisdiction and recognition of judgments

  1. What is the impact of Brexit on the parties’ choice of English law as the governing law of the ISDA Master Agreement? 

In the EU, the Rome I[3] and Rome II[4] Regulations deal with applicable law for contractual and non-contractual obligations respectively. Subject to limited exceptions, these Regulations give effect to the parties’ choice of applicable law.

9.1.  Will the Rome I and Rome II Regulations still apply post-Brexit?

  • When the UK leaves the EU, Rome I and Rome II will still apply in the EU and so any EU court dealing with a dispute under either of the ISDA Master Agreements will still have to apply these Regulations. In respect of the choice of English law, this means that EU courts will apply Rome I and (subject to the limited exceptions in the Regulation) give effect to the choice of English law as the governing law of the contract.
  • The ISDA Master Agreement (unless amended by the parties) is silent on the governing law of non-contractual obligations. However, since Rome II came into force in 2009, parties have commonly included an election in the Schedule to the ISDA Master Agreement to apply English law as the governing law of non-contractual obligations in connection with the contract. Post-Brexit, the position in respect of this choice of law to govern non-contractual obligations will be the same as in respect of the choice of law to govern contractual obligations; it will be respected by an EU court applying Rome II (again subject to the limited exceptions in the Regulation).
  • Once the UK has left the EU, and at the end of any proposed transition period, Rome I and Rome II, as directly applicable EU regulations, will cease to apply in the UK. However, for the transition period, the Draft Withdrawal Agreement states that Rome I shall continue to apply in the UK post-Brexit in respect of contracts concluded before the end of the transition period, and Rome II shall continue to apply in the UK post-Brexit in respect of events giving rise to damage which occurred before the end of the transition period. On the basis of the Draft Withdrawal Agreement as currently drafted, for English law governed ISDA Master Agreements entered into before the end of the proposed transition period, Rome I and Rome II will continue to determine the applicable law for relevant contractual and non-contractual obligations.
  • The European Union (Withdrawal) Bill (the “Withdrawal Bill”), if passed into law in its current form, will generally speaking preserve existing UK domestic legislation that implements EU laws (e.g. UK legislation implementing an EU directive) and incorporate directly applicable EU legislation (such as an EU regulation), so far as operative immediately before exit day, into UK domestic law on the exit day. Whilst this is the case, the Withdrawal Bill also gives the UK government powers to amend “deficiencies” in existing UK law, and retained EU law, so that they work appropriately once the UK has left the EU. These powers go beyond fixing technicalities to encompass, for example, reciprocal arrangements tied to the UK’s EU membership which a minister considers to be no longer “appropriate”. However, as neither Rome I, nor Rome II, depends on reciprocity in their operation, the most likely outcome seems to be that, to preserve continuity, the same provisions as are currently set out in the Rome I and the Rome II Regulations will be retained as part of UK domestic law pursuant to the Withdrawal Bill. Following the publication of the Withdrawal Bill, the UK government’s position paper entitled “Providing a cross-border civil judicial cooperation framework” published on 22 August 2017 confirmed that it is the intention of the UK to incorporate Rome I and Rome II into domestic law. If this happens, English law clauses specifying the governing law of contractual and non-contractual obligations (which fall outside of the scope of the provision in the Draft Withdrawal Agreement, to the extent that it is applicable) will also continue to be recognised by the English courts pursuant to such rules. If, contrary to the UK’s stated intention, the Rome I and Rome II Regulations are not retained as part of UK domestic law, then in proceedings before the English court, the common law position on the law applicable to contractual obligations prior to Rome I and any prior relevant legislation (i.e. the Contracts (Applicable Law) Act 1980) may be found to apply.

In these circumstances, applying the common law, English courts would be likely to continue to recognise and accept commercial parties’ choice of English law to govern their ISDA Master Agreements. In respect of non-contractual obligations, if Rome II is not incorporated into UK domestic law on the exit day, the rules set out in Part III of the Private International Law (Miscellaneous Provisions) Act 1995 (the “1995 Act”) will be applied. These look at a number of factors to work out which law applies to the non-contractual obligations, but the parties’ choice of law for contractual obligations is not expressly recognised as a factor. Therefore, if the parties have made an election of the governing law for non-contractual obligations, the express recognition of a choice pursuant to Rome II will no longer be determinative, but in practice such a choice is likely to be influential in an English court’s assessment of the law applicable to non-contractual obligations under the 1995 Act. If there is no election as to the governing law for non-contractual obligations, an English court will have regard to the test set out in the 1995 Act, and will likely take into account that the parties have chosen English law to govern their contractual obligations.

9.2.  Can the UK enact legislation replicating Rome I and Rome II entirely so as to maintain the status quo?

Yes, as discussed above the effective operation of Rome I and Rome II does not depend upon reciprocity. Accordingly, in order to preserve continuity, the UK government is to able retain the rules set out in Rome I and Rome II as part of UK domestic law within the framework of the Withdrawal Bill and has indicated an intention to do so.

9.3.  Is it advisable for parties to continue to amend the governing law clause of the ISDA Master Agreement to include an express choice of law for non-contractual obligations?

There is no reason not to continue including a choice of law for non-contractual obligations. This choice will be recognised by the EU courts and, under the current terms of the Draft Withdrawal Agreement, will continue to be recognised by the English courts if the ISDA Master Agreement is entered into before the end of the transition period.

Further, a choice of law for non-contractual obligations will be recognised by the English courts if Rome I and Rome II are incorporated into English domestic law, which is the UK government’s stated intention. Even failing such incorporation into English domestic law or if such rules are subsequently repealed by the UK Parliament, such choice of law is likely to be taken into account in the UK post-Brexit.

9.4. Is it advisable to change the governing law of the ISDA Master Agreement to (i) New York law or (ii) the law of an EU member state?[5]

Selecting New York law as the governing law (which would mean, unless agreed otherwise, a choice of court in favour of New York courts) is a possibility but there would be no real advantages in terms of the recognition of judgments of the US courts by either the EU or the English courts, particularly if Rome I and Rome II are incorporated into UK domestic law, which is the UK government’s stated intention.

Subject to the paragraph below, it is not advisable to change to any other governing law without legal advice as the ISDA Master Agreement has been drafted to operate under the legal regimes of New York and English law. Any such change from English law or New York law to a third country governing law would also necessitate further consideration of the jurisdiction clause, the application of ISDA commissioned netting and collateral opinions and the requirement of any contractual recognition provisions relating to bank resolution (see Question 26 (Additional provisions for inclusion in the ISDA Master Agreement)).

ISDA has commissioned the preparation of template French law and Irish law ISDA Master Agreements (and related collateral documentation). Those templates will therefore be governed by (and jurisdiction for disputes may be submitted to the courts of) an EU member state and will also form part of the ISDA framework – in particular, it is envisaged that the ISDA legal opinions will be updated in due course to contemplate these templates. Members should consider the impact of changes made to the English law ISDA Master Agreement in order to effect the transition to French or Irish law, as applicable, and of the underlying legal principles in these jurisdictions, on their derivative transactions.

  1. Will the jurisdiction clause of the ISDA Master Agreement still confer jurisdiction on the English courts where the parties to the ISDA Master Agreement are established in the EU? 

Currently, EU courts are bound to respect jurisdiction clauses in favour of another EU court on the basis of the Brussels I Recast Regulation. In addition, there are two further instruments which deal with recognition of contractual choice of jurisdiction: the Lugano Convention 2007, which deals with the position as between the EU member states and the other European Free Trade Association countries (Switzerland, Iceland and Norway) and the 2005 Hague Convention on Choice of Court Agreement, presently in force between the EU (excluding Denmark), Mexico and Singapore. The Brussels I Recast Regulation is a directly applicable EU regulation and the other two are instruments concluded by the EU in areas where it has exclusive competence. Once the UK withdraws from the EU, and if no other agreement is concluded or implemented in respect of the UK, none of these instruments will apply to it.

The provisions included in the Draft Withdrawal Agreement relating to the applicability of the Brussels I Recast Regulation post-Brexit (including in the proposed transition period) are not currently agreed between the UK and the EU27. The current draft provides that, post-Brexit, the UK and EU courts will be bound to respect jurisdiction clauses in favour of the EU and UK courts (respectively) if that jurisdiction agreement was concluded prior to the end of the transition period. The present position pursuant to the Brussels I Recast Regulation shall also apply to UK and EU courts in respect of the recognition and enforcement of judgments given in legal proceedings instituted before the end of the transition period. The 19 March 2018 draft therefore seems to represent a softening of the position adopted by the EU27 in the draft published on 28 February 2018, in which it was proposed that the provisions in the Brussels I Recast Regulation would only apply to the judgments of UK courts if those judgments had been handed down prior to the end of the transition period.

The position following transition is less clear. The UK government’s position paper entitled “Providing a cross-border civil judicial cooperation framework” published on 22 August 2017 states that the UK will seek an agreement between the UK and the EU27 that allows for close and comprehensive cross-border civil judicial cooperation on a reciprocal basis, which reflects closely the substantive principles of cooperation under the current EU framework (the major component of which is the Brussels I Recast Regulation). The UK has also stated in that paper that it will seek to continue to participate in the Lugano Convention and that it intends to participate (in its own right rather than through EU membership) in the Hague Conventions to which it is already party, including the 2005 Hague Convention. The UK therefore proposes a bilateral, reciprocal agreement with the EU27 which replicates the existing rules of the Brussels I Recast on jurisdiction and the recognition and enforcement of judgments, and (it would appear) a multi-lateral agreement in respect of continued participation in the Lugano Convention. If no agreement for retaining the current EU regime (or an equivalent) can now be reached (for example, if the EU27 does not agree to negotiate the terms of a replacement regime until the terms of the UK’s withdrawal are agreed) it is unlikely that the UK government would consider that unilateral retention of its rules as part of UK domestic law would be appropriate within the framework of the Withdrawal Bill since the Brussels I Recast Regulation depends upon reciprocity in order to function appropriately (for general observations on the UK government’s powers to correct “deficiencies” under the Withdrawal Bill, see Question 9.1 (Will the Rome I and Rome II Regulations still apply post-Brexit?) above). Also, in such circumstances, even if the UK did act unilaterally it would not mean that the UK would continue to be treated as if it were an EU member state by the remaining nations. Consequently, any unilateral incorporation of the current rules into English law would, in any event, be of limited effect and would not mean that proceedings in and judgments of UK courts would continue to be treated in the same way as proceedings in and judgments of EU courts, when it comes to matters of jurisdiction and the recognition of judgments in civil and commercial matters within the EU. The only likely action which the UK will (eventually) be able to take unilaterally in respect of jurisdiction and judgments will be to join the 2005 Hague Convention in its own right.

If (a) the current Draft Withdrawal agreement does not take legal effect; (b) there is no agreement as to the applicability of the Brussels I Recast Regulation post-Brexit; and (c) if the rules on recognition of jurisdiction clauses set out in the Brussels I Recast Regulation are, for whatever reason, not retained in UK domestic law, before the English courts, the ISDA jurisdiction clause is likely to be respected on the basis of common law rules, whether construed as an exclusive or a non-exclusive jurisdiction clause.

Irrespective of whether the Brussels I Recast Regulation is incorporated into UK domestic law (and absent of any other agreement between the UK and EU27) , before the EU courts, the UK will be a third country and EU courts will no longer be obliged to decline jurisdiction in favour of the English courts pursuant to an exclusive jurisdiction clause. In this respect the UK would be in no different a position from the US.

10.1 Will EU Regulation 1215/2012 (the Brussels I Recast) or its predecessors, Regulation 44/2001 (the Brussels Regulation) or the Brussels Convention, continue to apply? 

Neither Regulation is likely to apply. The Brussels Convention will continue to apply only for the purposes of some EU overseas territories and otherwise will likely not apply.

10.2 What about the Lugano Convention 2007 and the 2005 Hague Convention on Choice of Court Agreements? 

The Lugano Convention 2007 and the 2005 Hague Convention are conventions concluded by the EU which have direct effect in EU member states. They will no longer apply post-Brexit unless the UK independently contracts to become a convention state, which is its stated intention.

10.3 Can the UK unilaterally implement legislation replicating any of the existing EU legislation on recognition of jurisdiction so as to retain the status quo?

Not in a way that retains the status quo. As mentioned above, the Brussels I Recast Regulation depends upon reciprocity to work effectively. Once the UK ceases to be an EU member state, then, irrespective of whether its rules are retained in UK domestic law via the Withdrawal Bill, the UK (assuming no agreement has been reached with the EU27 as to its retention (or equivalent) and subject to any transitional arrangements agreed) would become a third country from the perspective of the other EU Member States. Thus, although, in such circumstances, retaining the rules of the Brussels I Recast Regulation in UK domestic law would permit continuity of recognition by the English courts of jurisdiction clauses in favour of another EU member state, and the English courts would continue to recognise and enforce EU judgments on the terms of those rules, the other EU member states would no longer be obliged by those rules to do the same in respect of the English courts. This illustrates why a unilateral retention of the rules in the Brussels I Recast Regulation by the UK government is not considered to be likely and why a reciprocal agreement with the EU27 is now sought by the UK.

10.4 What would be the position in respect of the 1992 ISDA Master Agreement (if construed as an exclusive jurisdiction clause in favour of English courts within the EU) where proceedings are brought before an EU court?

The provisions included in the Draft Withdrawal Agreement relating to the applicability of the Brussels I Recast Regulation post-Brexit (including in the proposed transition period) are not currently agreed between the UK and the EU27. On the basis of the current draft of the Draft Withdrawal Agreement, if the ISDA Master Agreement is entered into before the end of the transition period, the relevant EU court will be obliged to respect that jurisdiction clause and decline jurisdiction in favour of the English courts in accordance with the Brussels I Recast Regulation.

If the UK and EU27 fail to agree the relevant provisions of the Draft Withdrawal Agreement, and/or for choices of jurisdiction made after the end of the transition period, and if the clause is regarded as fully exclusive within the EU, there will be uncertainty as to whether an EU court will decline jurisdiction in favour of the English courts if England is not an EU or a Lugano Convention state. However, if proceedings are also brought in the English courts, the English courts would, post-Brexit (and provided that the rules in the Brussels I Recast Regulation are not, whether pursuant to a negotiated agreement or (less likely) unilaterally, replicated in UK domestic law), likely have the power to issue an antisuit injunction to restrain proceedings brought elsewhere in the EU to protect their jurisdiction under an exclusive jurisdiction clause, which they are currently unable to do.

10.5 What would be the position in respect of the ISDA 2002 Master Agreement (if construed as a non-exclusive jurisdiction clause in favour of English courts) where proceedings have been commenced in the English courts and subsequent proceedings are brought before an EU court?

The provisions included in the Draft Withdrawal Agreement relating to the applicability of the Brussels I Recast Regulation post-Brexit (including in the proposed transition period) are not currently agreed between the UK and the EU27. On the basis of the current draft of the Draft Withdrawal Agreement, if the ISDA Master Agreement is entered into before the end of the transition period, the EU court will be obliged to respect the jurisdiction clause and so, if the English courts are first seised, the EU court will be required to stay its proceedings until the jurisdiction of the English courts is established, at which point the EU court must decline jurisdiction in accordance with the Brussels I Recast Regulation.

If the UK and EU27 fail to agree the relevant provisions of the Draft Withdrawal Agreement, and/or for choices of jurisdiction made after the end of the transition period, there will be uncertainty as to whether the EU court would decline jurisdiction or stay proceedings on the basis that the English courts are first seised. However, provided that the rules in the Brussels I Recast Regulation are not, whether pursuant to a negotiated agreement or (less likely) unilaterally, replicated in UK domestic law and subject to any transitional arrangements agreed, English courts will have greater freedom to accept jurisdiction and will not be constrained by any rules regarding litigation in other jurisdictions.

10.6 What would be the position in respect of either the ISDA 2002 Master Agreement or the 1992 ISDA Master Agreement where proceedings are brought before the English courts and neither party is domiciled in the UK? 

As the ISDA Master Agreement contains a clause conferring jurisdiction on the English courts, the English courts are likely to accept jurisdiction, irrespective of whether the Brussels I Recast Regulation has been converted into UK domestic law (whether pursuant to a negotiated agreement or (less likely) unilaterally).

  1. What is the impact of Brexit on arbitration clauses in an ISDA Master Agreement which select England as the seat of arbitration?

Arbitration clauses, such as the ISDA model clauses in the 2013 ISDA Arbitration Guide, will be unaffected by the UK leaving the EU as arbitration is regulated by national law (the UK’s Arbitration Act 1996) and non-EU international instruments (the New York Convention on the Recognition of Foreign Arbitral Awards, to which the UK is already a signatory in its own right). An arbitral award made in the UK should be recognisable and enforceable in the EU member states, and vice versa, on this basis.

11.1 Where parties currently have an English governing law and jurisdiction clause in their ISDA Master Agreement, is there merit in retaining a choice of English law, but inserting an arbitration clause into the ISDA Master Agreement? 

Arbitration is a potential work-around to avoid the uncertainty as to whether an English jurisdiction clause will be respected in the EU courts. Arbitration may also be a potential workaround to make jurisdiction clauses compliant for the purposes of MiFID II equivalence (see Question 13 (Factors which will determine the choice of law/jurisdiction clause)).

  1. What are the consequences of Brexit for the recognition and enforcement of judgments where: 

12.1 enforcement of a judgment issued by an English court is sought in an EU court?

The provisions included in the Draft Withdrawal Agreement relating to the applicability of the Brussels I Recast Regulation post-Brexit (including in the proposed transition period) are not currently agreed between the UK and the EU27. Under the current draft of the Draft Withdrawal Agreement, if the judgment is issued by the English court before the end of the transition period, the EU court will be required to recognise and enforce that judgment, in accordance with the Brussels I Recast Regulation.

If the terms contained in the current draft of the Draft Withdrawal Agreement are not agreed, or with respect to judgments issued by the English court after the end of the transition period (were the Draft Withdrawal Agreement agreed in its current form), and assuming that no other agreement is concluded or implemented in respect of the UK, this will depend on the rules of private international law of the jurisdiction in which enforcement is sought. There will likely be more procedural and substantive conditions to enforcement. For a number of EU jurisdictions, no significant hurdles are anticipated but for others the outcome will be uncertain. Local law advice will be needed on a jurisdiction-by-jurisdiction basis.

12.2 enforcement of a judgment issued by an EU court is sought in the English courts?

The provisions included in the Draft Withdrawal Agreement relating to the applicability of the Brussels I Recast Regulation post-Brexit (including in the proposed transition period) are not currently agreed between the UK and the EU27. Under the current draft of the Draft Withdrawal Agreement, if the judgment is issued by the EU court before the end of the transition period, the English court will be required to recognise and enforce that judgment, in accordance with the Brussels I Recast Regulation.

If the terms contained in the current draft of the Draft Withdrawal Agreement are not agreed, or with respect to judgments issued by an EU court after the end of the transition period (were the Draft Withdrawal Agreement agreed in its current form), and again on the assumption that no other agreement is concluded or implemented in respect of the UK, EU judgments will continue to be enforceable by the English courts based on common law, especially where the judgment is from a court chosen by the parties.

  1. Are there any other factors which will determine the choice of law/jurisdiction clause in an ISDA Master Agreement post-Brexit? 

The ISDA Master Agreements have been drafted with English and New York law in mind (although see Question 9.4 (Is it advisable to change the governing law of the ISDA Master Agreement to (i) New York law or (ii) the law of an EU member state?) in relation to the French and Irish law ISDA Master Agreements commissioned by ISDA). There is benefit, therefore, in retaining English law (or New York law) as the governing law and having an English court (or New York court) resolve any disputes as to the terms of the agreement. There may be circumstances in which the parties’ identity and location of their assets, the recognition of third country jurisdiction clauses by the courts of a particular jurisdiction and/or enforcement of judgments in such jurisdiction may lead the parties to consider whether an alternative governing law/jurisdiction clause is suitable. In those circumstances, a careful analysis of how claims would be considered under a different system of law and different procedural rules would need to be undertaken as well as due diligence on enforcement of netting and collateral.

If the UK loses its financial services passport under MiFID II, which seems probable based on the UK’s stated intention to leave the single market,[6] it will be open to the UK to seek an equivalence decision from the European Commission (which in theory may be granted given that, at the point of exit, the UK’s regulatory regime will be equivalent with the EU’s)[7]. Third country firms (such as UK firms post-Brexit) relying on the MiFID II equivalence regime to provide MiFID II services to eligible counterparties or professional clients in the EU will have to comply with Article 46(6) of MiFIR[8] which would require such third country firms to offer to submit disputes relating to those services or activities to the jurisdiction of a court or arbitral tribunal in an EU member state. This requirement does not impact the parties’ choice of governing law. However, there is some uncertainty as to what is required by Article 46(6). Arguably, the only course of action which can be said to certainly comply with the provision is to make an entirely open offer to submit any such disputes to the jurisdiction of a court or arbitral tribunal in an EU member state. It would then open to the EU counterparty to refuse the offer in favour of, for example, the use of a third country’s courts.

Article 46(6) does not apply to the extent a third country firm establishes a branch in an EU member state pursuant to Article 39 of MiFID II (whether for the purpose of providing services/activities to retail clients in that EU member state or for the purpose of cross-border provision of services pursuant to Article 47(3) of MIFIR). If there is no need to satisfy the Article 46(6) requirement and the counterparty is not content to use the English courts, UK counterparties to an ISDA Master Agreement may select the jurisdiction of an EU court or include an arbitration clause which selects an EU place as the seat of arbitration. This would not necessarily require a change of the choice of English law as the governing law.

There are other provisions of EU legislation under which it may be beneficial for the governing law of an ISDA Master Agreement to be that of an EU member state. Each of the Credit Institutions (Reorganisation and Winding-up) Directive[9], Solvency II Directive[10] and EU Recast Regulation on Insolvency Proceedings (“EIR”)[11] provide that the law of the home member state of the credit institution or insurance undertaking, as applicable, being wound-up (or, in the case of the EIR, the EU member state in which the insolvency proceedings are opened) shall determine certain points in relation to the winding-up or insolvency proceedings. This is, however, subject to a number of exceptions. One of these exceptions is in the context of ‘legal acts detrimental to all creditors’, where (i) such act is subject to the law of an EU member state other than the home member state or the EU member state in which the insolvency proceedings are opened, as applicable, and (ii) that law does not allow any means of challenging the act in the relevant case.[12] (i) and (ii) are required to be proven by a beneficiary of the relevant legal act. Where this is proven, the law of the home member state or EU member state in which the insolvency proceedings are opened, as applicable, cannot be used to invalidate such act or make such act unenforceable. Prior to the UK becoming a third country for the purposes of these pieces of EU legislation, if, for example, a delivery was made under an English law governed ISDA Master Agreement by an EU- (but non-UK)-incorporated entity which at the time (or subsequently) became subject to winding-up or other insolvency proceedings which fall under one of these pieces of EU legislation, provided that such dispositions of property cannot be challenged under English law, insolvency officials of the insolvent entity (or entity being wound-up) would not be able to invalidate such disposition. This protection would fall away once the UK is no longer part of the EU as ‘legal acts’ carried out pursuant to an English law ISDA Master Agreement would no longer be subject to the law of an EU member state. In such circumstances, the outcome will depend on the position under the laws of the home member state or the EU member state in which the insolvency proceedings are opened, as applicable, and whether such laws allow the relevant disposition (or other act) to be invalidated in the relevant circumstances.

See also Question 25 (Post-Brexit, what additional provisions will counterparties need to include in their ISDA Master Agreements to address requirements under the BRRD when facing an EU counterparty?) in relation to BRRD.

See also Question 9.4 (Is it advisable to change the governing law of the ISDA Master Agreement to (i) New York law or (ii) the law of an EU member state?) for more detail on the ISDA commissioned French and Irish law ISDA Master Agreements.

  1. What amendments can parties make to Section 13 (Governing Law and Jurisdiction) to mitigate the uncertainty surrounding recognition of English choice of law/jurisdiction clauses?

The Section 13(b) jurisdiction clauses may require re-visiting following the UK’s withdrawal to re-define the scope of exclusivity/non-exclusivity. In the meantime, parties may consider removing uncertainty as to the treatment of Section 13(b) post-Brexit themselves by making any of the following changes:

fully exclusive jurisdiction clause: post-Brexit, if the European legislation on recognition of jurisdiction is no longer applicable in the UK, there may be further debate about whether or not the jurisdiction clause in the ISDA Master Agreements is an exclusive jurisdiction clause. Inserting a wholly exclusive jurisdiction clause avoids this issue arising and if (as is its stated intention) the UK independently ratifies the 2005 Hague Convention on Choice of Court Agreements any exclusive jurisdiction clause would in due course be recognised by convention signatories (which includes the EU, excluding Denmark). In that event, however, because of the operation of the 2005 Hague Convention’s provisions on its entry into force, there may be some doubt as to whether that Convention can apply to such a clause entered into before the Convention comes into force in relation to the UK pursuant to any such independent ratification by it (i.e. such clauses concluded whilst the UK was an EU Member State). This may restrict the Convention’s usefulness in relation to clauses entered into before that happens. 

fully non-exclusive jurisdiction clause: this approach would also remove any uncertainty as to whether the jurisdiction clauses are exclusive or non-exclusive in the EU and gives parties the maximum range of options to bring proceedings against their counterparty where it has assets. 

asymmetrical clauses: a combination of both exclusive and non-exclusive jurisdiction clauses can be inserted. This is increasingly common in commercial contracts where one party wishes to retain the option to bring proceedings against its counterparty where it has assets but impose the exclusive jurisdiction of the English courts on its counterparty in respect of proceedings against itself. The English courts will give effect to such asymmetrical clauses. 

arbitration clauses: as discussed in the answer to Question 11 (Impact of Brexit on arbitration clauses), arbitration clauses are unaffected by the UK’s withdrawal from the EU and, because of the New York Convention, there is already a wide and certain regime for enforcing arbitral awards. Where parties are keen to continue using English law but are worried about the possibility of having to enforce against assets held in the EU, then switching to arbitration is an obvious choice to consider. Arbitration may also solve the issue of any future compliance with Article 46(6) of MiFIR for UK parties seeking to enter into derivative transactions with counterparties in the EU under the MiFID II equivalence regime (see Question 13 (Factors which will determine the choice of law/jurisdiction clause)).

Insolvency

  1. How will English insolvency proceedings in respect of a UK entity be recognised in the EU post-Brexit?

Brexit may, depending on its final form, create uncertainty in relation to insolvencies involving UK companies that have businesses or significant assets located in EU member states or companies incorporated in EU member states with businesses or significant assets located in the UK. This is because insolvency proceedings commenced in EU member states (other than Denmark) are currently subject to the EU Recast Regulation on Insolvency Proceedings (“EIR”), which contains a framework of rules governing (i) where insolvency proceedings may be opened, (ii) the laws applicable to certain matters arising in such proceedings and (iii) the recognition of proceedings in other EU member states. Recognition under the EIR is currently reciprocal and automatic in nature.
Unless otherwise agreed, the EIR would cease to apply to the UK once it leaves the EU, with the result that UK insolvency officeholders would no longer automatically be recognised in the remaining EU member states as having the power to deal with assets located in those EU member states or as having the right to enforce insolvency-related judgments against entities located in those EU member states.

This would introduce an apparent element of asymmetry, as while insolvency officials in the remaining EU member states would no longer benefit from automatic recognition in the UK pursuant to the EIR, they could still benefit from the (more limited) recognition provisions contained in the UNCITRAL Model Law on Insolvency (the Model Law), which the UK has implemented in the form of the Cross-Border Insolvency Regulations 2006. Insolvency officials in such EU member states would therefore still be recognised as having the power to deal with assets located in the UK, although there would be issues surrounding the enforcement of foreign insolvency judgments in the UK, as such enforcement currently falls outside the scope of the Model Law.
UK officeholders would not be in the same position, as, across the EU, only Greece, Poland, Romania and Slovenia have currently implemented the Model Law. In any other EU member state, a UK officeholder seeking recognition would, as was the case before the EIR came into force, have to seek recognition under the local domestic law of the relevant EU member state.
The question of how easy it would be for a UK officeholder to obtain such recognition, typically using what is known as the “exequatur” procedure, would vary significantly from jurisdiction to jurisdiction, but in most cases the process would become considerably more difficult if the debtor’s centre of main interests (which broadly equates to its head office function) was not located in the UK.
UK members’ voluntary liquidations and receiverships would be unaffected, as they are currently outside the scope of the EIR.
The Credit Institutions (Reorganisation and Winding-up) Directive and the Solvency II Directive will no longer cover the UK. This means that provisions relating to the recognition of English insolvency proceedings by courts in EU member states would no longer apply, unless the EU member state in question chose to allow their continued application, in its domestic legislation, to UK credit institutions and insurers.
The position in relation to recognition in the UK under the Credit Institutions (Reorganisation and Winding-up) Directive and the Solvency II Directive will depend whether the UK choses to repeal the statutory instruments under which those EU directives became part of the UK’s domestic legislation pursuant to powers contained in the European Communities Act 1972 (the “1972 Act”).
When the 1972 Act is repealed, such secondary legislation could (subject to the UK government’s powers to correct “deficiencies” under the Withdrawal Bill – see Question 9.1 (Will the Rome I and Rome II Regulations still apply post-Brexit?) above) be preserved under proposals currently contained in the Withdrawal Bill allowing English courts to recognise EEA insolvency proceedings. However, if the statutory instruments are not retained in UK domestic law pursuant to the Withdrawal Bill, or are subsequently repealed by the UK Parliament, recognition of foreign insolvency proceedings involving EEA credit institutions and certain insurers would revert back to the common law position, as such entities are carved out of the Cross-Border Insolvency Regulations 2006.
English courts will only take jurisdiction in relation to a scheme of arrangement proposed by a foreign company if they are satisfied that effect of the scheme would be recognised in the jurisdiction where the debtor company was domiciled. This point is currently generally addressed, when a scheme is proposed by a debtor incorporated in an EU member state, by reference to the recognition provisions contained in the Brussels I Recast Regulation (see the answer to Question 12 (What are the consequences of Brexit for the recognition and enforcement of judgments where…) although there are additional complexities when dealing with insolvency-related judgments). The negative impact of this could, however, be mitigated if the UK agreed to become a convention state under the Lugano Convention 2007 and/or the 2005 Hague Convention.
Assuming no agreement is reached as part of the UK’s withdrawal from the EU as to the continued application of the recognition provisions in the Brussels I Recast Regulation, the position would become more complex, but if courts in the remaining EU member states were to characterise the recognition of schemes as falling within conflicts rules relating to contracts, a scheme proposed by a company domiciled in their jurisdiction could, as long as it related only to contracts governed by English law, still be recognised on the basis of Article 12(1)(d) of the Rome I Regulation, which provides that, subject to certain exceptions, EU member states should, even post-Brexit, recognise that English law should govern the “various ways of extinguishing obligations” under English law contracts.

Access to the EU financial markets

  1. What is the impact of Brexit on the ability of financial services firms established in the UK to enter into OTC derivatives with counterparties established in the EU?

Passporting rights: Currently a UK bank/investment firm which is authorised to enter into wholesale OTC derivatives in the UK can apply to its home regulator (i.e. the Prudential Regulation Authority or the Financial Conduct Authority) for a passport to provide those services in any other EU member state either via a branch or on a cross-border basis. These “passporting rights” are granted pursuant to the EU financial services directives (notably, MiFID II[13] for investment services and CRD IV[14] for credit institutions providing banking services). When the UK leaves the EU, these Directives will no longer grant this passporting right to UK entities. It is possible that the passporting rights of UK firms into the EU (and EU firms into the UK) will continue, after the UK leaves the EU, during a limited transitional period to be negotiated between the EU and the UK. Such passporting rights would continue under the transitional period currently proposed in the Draft Withdrawal Agreement.
UK firms wishing to enter into OTC derivatives with counterparties in the EU would then be subject to the regulations in such EU member state. In many EU member states, firms which are not authorised locally, and do not have an EU financial services passport, are not permitted to enter into derivative transactions with locally resident counterparties except on a reverse-solicitation basis (that is, where the counterparty has solicited the business of the UK firm, rather than the UK firm soliciting business in the jurisdiction)[15], or on the basis of narrowly defined local law exemptions or licences which may be available in some cases.
The position with respect to OTC derivatives entered into by UK firms with counterparties in the EU prior to the date on which the UK leaves the EU will also be subject to regulations in the applicable EU member state (possibly only after the end of any agreed transitional period (such as that currently proposed in the Draft Withdrawal Agreement) and subject to anything that is agreed between the UK and the EU on point as part of the exit negotiations). In relation to such transactions, the performance of existing obligations would not seem to fall within MiFID II as it does not involve the provision of an investment service or ancillary activity which is covered by MiFID II. Specifically, it does not involve the reception or transmission of orders, the execution of orders or dealing on own account. For performance of such existing obligations under a transaction that was entered into prior to the date on which the UK leaves the EU to be subject to authorisation, therefore, (a) the local jurisdiction would have to have implemented MiFID II in a way which goes beyond the requirements of MiFID II, (b) there would have to be a change in law at European or local law level or (c) the local regulator would need to take a particularly restrictive view as to what activity non-authorised entities are permitted to carry out in their jurisdiction. Although it is expected that in most instances performance of pre-existing contractual obligations would not be subject to local authorisation requirements, there is a risk that such activity is treated otherwise by certain EU regulators, particularly where performance involves the transfer of MiFID II financial instruments (not including cash). There is also a risk that certain EU regulators take a restrictive view more generally with respect to non-authorised UK firms continuing to be counterparty to pre-existing transactions with local entities, and require that such transactions are novated to an appropriately authorised entity.
Also, certain events or actions may occur during the life of an existing OTC derivative transaction, some of which could be viewed as more than the mere performance of a pre-existing contractual obligation. If such an event could be construed as entry into a new derivative transaction that is subject to either MiFID passporting or authorisation in the relevant EU member state, then loss of the passport could render such activity illegal in the EU. This will depend on whether the event involves the provision of an investment service (essentially a dealing type activity that in effect involves entering into a new trade in a “financial instrument”), although in at least some member states, engaging in these activities on a reverse-solicitation basis (that is, where the counterparty has solicited the business of the UK firm, rather than the UK firm soliciting business in the jurisdiction) may fall outside the scope of the regulatory regime while in other jurisdictions other exemptions may be available. This issue may be more relevant for certain product types, for example swaptions (where exercise of the swaption results in a new derivative transaction arising). The outcome would need to be assessed on a jurisdiction by jurisdiction basis in light of the total loss of passporting rights, assuming the absence of an equivalence decision or individually negotiated position retaining access for UK financial service firms to EU financial markets. UK firms should also consider whether communication with their EU counterparty in connection with a legacy transaction could constitute the provision of investment advice, which is also regulated under MiFID II (and which will therefore also be impacted were a UK firm to lose its passporting rights). ISDA has obtained high level, summary advice from counsel in France, Germany, Italy, the Netherlands and Spain, as well as the UK, as to the expected regulatory treatment (under current law and regulation) of certain lifecycle and other events, which is available here.

This advice indicates that the following events (of those considered) are likely to trigger authorisation requirements in the relevant EU member state (unless an exemption applies):

(a) rolling an open position;

(b) ‘material’ amendments to the terms of the transaction;

(c) novations (the exact regulatory impact will depend on the precise capacity in which a party acts (remaining party, transferor or transferee), as well as the location of each such party);

(d) unwinds (where undertaken by way of entering into an offsetting transaction); and

(e) portfolio compression (where undertaken by way of termination of existing transactions and entering into one or more replacement transactions).

UK firms should consider which of their counterparties are ‘in the EU’ for regulatory purposes. There are a variety of factors which could bring a client within the regulatory scope of an EU member state, including the nature of the counterparty. In particular, consideration should be given to the position with respect to counterparties entering into derivative transactions as agent for underlying principals (e.g. investment managers). It is not necessarily the case that, where the agent is located outside the EU, such derivative transactions are not subject to the issues around loss of passporting rights as, in some instances, the UK firm may be required to ‘look through’ the agent to the underlying principal in order to identify their client for regulatory purposes.

See Question 16.1 (Will EU firms without a UK branch still be able to carry out derivatives business in the UK?) for more details regarding the lifecycle and other events which may require EU counterparties to be authorised in the UK once the UK has left the EU (unless an exemption applies).

MiFID II/MiFIR equivalence: In the absence of a specially negotiated position, the UK would be a third country for the purposes of the EU financial services directives. However, MiFID II/MiFIR[16] contains third country provisions. Article 46(1) of MiFIR grants third country firms the right to become registered with ESMA to provide investment services to eligible counterparties and professional clients in the EU if the European Commission makes an equivalence determination, that is, a determination that the legal and regulatory regime of the third country is equivalent to the prudential and conduct of business requirements of MiFID II/MiFIR. However, not all of MiFID II is covered by the equivalence regime, for example, dealings with retail clients and elective professional clients are not covered.

Given that MiFID II/MiFIR has been implemented in the UK, and having regard to the UK government’s proposals under the Withdrawal Bill, it is likely that the UK will incorporate existing EU regulations such as MiFIR into UK domestic law to maintain the status quo, at least initially. Therefore, the UK regime should, objectively, be equivalent for the purposes of an equivalence decision under Article 47 of MiFIR. In practice, however, there is no guarantee that an equivalence decision would be forthcoming and in any event there is still gap risk as ESMA has 180 working days in which to determine whether an application by a firm for registration should be granted.[17]

CRD IV: UK credit institutions are currently authorised to conduct banking services pursuant to the UK implementation of CRD IV and have passporting rights pursuant thereto. CRD IV contains no provisions for third country equivalence. In the absence of an agreement between the UK and the EU to extend the CRD IV passport to the UK, a UK credit institution would either have to provide banking services on a reverse-solicitation basis, or on the basis of narrowly defined local law exemptions, or would need to establish a subsidiary and obtain authorisation in an EU member state. That subsidiary would then be able to provide banking/investment services through the rest of the EU on the basis of the passport. However, in respect of MiFID II investment services, including dealing on own account or execution of orders in respect of derivatives which constitute MiFID II financial instruments, a UK credit institution would still have the option of relying on the MiFIR third country equivalence regime to provide these investment services in the EU if an equivalence determination were made – see sub-paragraph (ii) .

Energy and commodities: Where the OTC derivative transaction is a physically-settled energy or commodity transaction, Brexit may have certain additional regulatory consequences.

(a) REMIT[18] requires persons who enter into wholesale energy products (including derivatives relating to electricity or natural gas produced, traded or delivered in the EU, and derivatives relating to the transportation of electricity or natural gas in the EU, but excluding any financial instruments regulated by the Market Abuse Directive) to be registered in the EU member state in which they are established or resident or, if not established or resident in an EU member state, the EU member state in which they are active. Any such market participants registered in the UK may need to re-register in an EU member state post-Brexit. This would need to be done prior to entering into any transaction with respect to such a product on any market within the EU.

(b) REACH[19]

regulates the manufacture, placing on the market (including import) and use of substances on their own, in mixtures and to a limited extent in articles; and imposes registration requirements on, amongst others, EU manufacturers and importers of certain chemical substances. The settlement of many transactions is undertaken within customs-free zones where REACH requirements would not ordinarily be engaged. To the extent a physically-settled commodity derivative would require delivery of a substance or article into the EU where previously it would have been treated as taking place within the EU, the requirement to register may be triggered. This would typically result in the party importing the substance into the EU registering the substance and complying with any other requirements under REACH applicable to it. Furthermore, companies that hold REACH registrations through UK entities cannot presently transfer those registrations to other EU domiciled entities within their group upon Brexit, necessitating a whole new registration process for the EU entity as either an importer or only representative of the UK entity. Although the UK has indicated it would like to explore associate membership of the European Chemicals Agency after leaving the EU at the end of any agreed transitional period (which might allow UK-held REACH registrations to meet the registration requirement)[20], the UK is also planning as a contingency to replicate REACH in the UK post-Brexit, meaning EU entities holding REACH registrations may also need to re-register substances or articles in the UK post-Brexit (unless current EU registrations are recognised by the UK)[21].

(c) The EU ETS[22] regulates the allowance system for greenhouse gas emissions in the EU. In 2012 the EU ETS operations were transferred to a centralised single EU registry, the Union Registry, covering all countries participating in the EU ETS, including the UK. The Union Registry (including its technical infrastructure) is operated and maintained by the central administrator[18], with each EU member state responsible for administering its ‘part’ within the Union Registry. Under the EU ETS, companies or individuals holding or trading emission allowances are required to hold such allowances in a Union Registry account administered on behalf of an EU member state or the EU.

The UK part of the Union Registry is administered by the Environment Agency in its capacity as the UK’s national administrator. A national administrator’s main responsibilities are to be the contact point for their respective account holders in the Union Registry and to perform all operations involving direct contact with them (such as opening, suspension and closure of accounts). The central administrator has the responsibility to provide, operate and maintain the Union Registry and the European Union Transaction Log and to perform operations which are carried out centrally. This includes processing transaction[23] instructions issued by any account holder[24]. In the short term, trader account holders may continue to have access to their account in the UK part of the Union Registry and may be able to trade from that account (for example, where an OTC derivative transaction requires a UK counterparty to transfer emission allowances to an EU counterparty) following the UK’s exit from the EU.

However, the Environment Agency or Natural Resources Wales (as a part of the UK) may consider that it does not have the authority to perform certain functions which imply longer term participation in the Union Registry.

Transitional arrangements could be sought which either: (i) enable a transfer of existing trading accounts to an alternative EU member state (similar to the process currently contemplated in connection with aviation operators); or (ii) appoint an alternative administrator on behalf of the EU to administer accounts currently held in the UK part of the Union Registry.[25]

It is also possible that the UK and the European Commission agree to a linking mechanism whereby trading account holders would continue to participate in the EU ETS in much the same way as they currently do. In relation to the EU ETS, the UK and EU are negotiating a transitional period (as proposed in the Draft Withdrawal Agreement) where the UK and EU would continue to have access to each other’s markets on current terms.[26]

It is unlikely that trader accounts in the UK part of the Union Registry would be closed or be subject to access restrictions unilaterally following the UK’s exit from the EU (or the end of the transitional period, if this is agreed). An account can only be closed by the administrator on application by the account holder and there are clearly defined conditions for an administrator to impose access restrictions, none of which are triggered by the UK’s exit from the EU.

It is unlikely that trader accounts in the UK part of the Union Registry would be closed or be subject to access restrictions unilaterally following the UK’s exit from the EU (or the end of the transitional period, if this is agreed). An account can only be closed by the administrator on application by the account holder and there are clearly defined conditions for an administrator to impose access restrictions, none of which are triggered by the UK’s exit from the EU.

The EU had been concerned that, assuming the UK leaves the EU on 29 March 2019, there will be no obligation after that date for entities to surrender allowances for the 2018 EU ETS compliance year (ordinarily the surrender deadline would be 30 April 2019). Without changes to the EU ETS, UK allowance holders could therefore sell their allowances to entities still in the EU after 29 March 2019, potentially weakening the market for allowances. As a result, the European Commission has amended the EU ETS to provide for the marking of allowances issued by the UK on or after 1 January 2018 with a UK country identifier, and invalidating those allowances for surrender from 1 January 2018, except where the UK either: (i) ensures, in a legally enforceable manner, that the allowances for the 2018 EU ETS compliance year must be surrendered by 15 March 2019; or (ii) EU law continues to apply in the UK on 30 April 2019 (i.e. a transitional period, such as that proposed in the Draft Withdrawal Agreement, is agreed). [27]

The UK has already implemented the first option provided by the EU and the EU ETS in the UK has been amended to bring forward the 2018 deadline for surrendering allowances from 30 April 2019 to 15 March 2019.[28] The European Commission has confirmed publicly that this will avoid the marking/invalidating of UK allowances.[29] Consequently, UK entities should be aware that the deadline for surrender of allowances has been brought forward for the 2018 EU ETS compliance year.

In addition, the Draft Withdrawal Agreement includes an EU proposal that the UK will remain in the EU ETS for the last year of the transition period (from 1 January 2020 to 31 December 2020 – the end of the third phase of the EU ETS), have the obligation to surrender allowances for that period and that the United Kingdom and UK operators will have access to the Union Registry to the extent necessary to comply with that membership of the EU ETS.[30] However, this proposal has not as yet been agreed to by the UK.

Continued compliance with certain EU legislation: Even in a Brexit scenario, with no retention of passporting rights and no MiFID II equivalence decision, UK financial services firms providing services on a cross-border basis will still be required to comply with certain EU legislation in order to transact with EU counterparties due to their extra-territorial effect. This is the case for provisions of the Market Abuse Directive/Market Abuse Regulation (as well as certain market abuse provisions of REMIT), and some aspects of MiFID II/MiFIR and EMIR (e.g. the position limits for commodity derivatives under MiFID II, and the margin rules under EMIR which apply to certain third country entities).

16.1 Will EU firms without a UK branch still be able to carry out derivatives business in the UK?

If the transitional period proposed in the Draft Withdrawal Agreement comes into force, EU firms would still be able to rely on their existing passporting rights during that period. The Bank of England announced on 28 March 2018 that it is reasonable for EU firms currently relying on passporting rights to provide services in the UK to assume that PRA authorisation will only be needed by the end of this transitional period, and the FCA separately announced on 28 March 2018 that firms need not apply for authorisation at this stage. Further, the UK Government announced on 20 December 2017 that it will, if necessary, bring forward legislation to enable EU firms operating in the UK to continue to do so after the UK leaves the EU under a “temporary permission” (to allow such firms to continue to access the UK market for a temporary period even in the event of no withdrawal agreement being agreed). The FCA announced on 28 March 2018 that, subject to such legislation being put in place, their expectation is that firms that will be solo-regulated by the FCA will need to notify the FCA of their desire to benefit from this temporary permissions regime. Further details on this are expected in due course.[31]

[31]   https://www.fca.org.uk/news/statements/fca-statement-eu-withdrawal-following-march-european-council

The UK has a wide overseas persons exemption for overseas persons without a place of business in the UK and it is possible that OTC derivatives business could be conducted by EU firms with UK counterparties on that basis following expiry of any such transitional period or temporary permission (or, failing any transitional relief being negotiated or temporary permission being available, from when the UK leaves the EU).

The requirements of the overseas person exemption largely require dealing either exclusively with or through authorised UK firms, or otherwise in a manner consistent with the UK financial promotions regime. This is on the basis of the existing position in the UK and it is not inconceivable that this could be changed post-Brexit.

ISDA has obtained high level, summary advice as to whether certain events or activities which may occur during the life of an existing OTC derivative transaction could trigger authorisation requirements for EU counterparties in the UK (to the extent the overseas persons exemption was not available). This advice as to the regulatory treatment (under current law and regulation) of certain lifecycle and other events, is summarised here. As well as the events and activities which are likely to trigger authorisation requirements for UK counterparties in EU member states (see Question 16 (What is the impact of Brexit on the ability of financial services firms established in the UK to enter into OTC derivatives with counterparties established in the EU?)), certain additional events may trigger authorisation requirements in the UK. These include exercising options, transfers of collateral and unwinds/portfolio compression carried out by any methodology.

16.2 Will EU firms still be able to carry out derivatives business through a UK branch post-Brexit?

EU firms that carry on investment business from their UK branches will likely need to re-apply for authorisation in the UK if the EU passport is withdrawn.

On 20 December 2017 HM Treasury, the Bank of England, the PRA[32] and the FCA[33] issued a series of announcements, including statements that:

  • the PRA is consulting on a revised approach to branch authorisation and supervision that, importantly, envisages allowing third country (including EU) banks to operate in the UK through branches, rather than having to establish a subsidiary, except where material retail banking business is conducted in the UK; and
  • if necessary, the UK Government will legislate to enable EU firms that operated in the UK before the UK leaves the EU to continue to undertake activities in the UK within the scope of their existing permissions for a limited period of time (“temporary permissions”).

On 28 March 2018, the PRA issued a further series of announcements[34] setting out its approach to branch authorisation and supervision and confirmed that EU banks and insurers may (if they are not conducting material retail business) apply for authorisation to operate a branch in the UK. Whether the PRA authorises such branch will depend on a number of factors, and particularly whether the relevant branch is a ‘systemic wholesale branch’ (i.e. a branch of an international bank undertaking wholesale activities in the UK which are determined to be systemically important), the equivalence of the regulatory regime in the bank’s home jurisdiction with the UK and whether there is felt to be sufficient supervisory cooperation between the PRA and the bank’s local regulator. Where the PRA is not satisfied, the PRA may impose specific regulatory requirements at the branch level or, if such requirements prove to be ineffective, the PRA would likely be prepared to authorise the firm only as a subsidiary. EU firms should consider the scope of activities they are intending to carry out through UK branches across their group in light of these statements.

EMIR

  1. Will UK OTC derivative counterparties still be required to comply with the clearing, reporting and risk-mitigation requirements under EMIR?

Post-Brexit, EMIR will no longer apply directly in the UK. However, it seems likely that the UK will retain these requirements as part of the incorporation of directly applicable EU legislation pursuant to the proposals in the Withdrawal Bill and, in any event, in order for the UK to obtain an equivalence decision pursuant to EMIR, it would need to replicate those requirements in the UK.  Assuming that the Withdrawal Bill is enacted in its current form and incorporates the current provisions of EMIR and the delegated regulations made thereunder into UK domestic law, UK OTC derivative counterparties will continue to be subject to the same (or substantially similar) rules on clearing, reporting and risk-mitigation techniques for OTC derivatives.

Even if that is not the case, a UK derivative counterparty entering into an OTC derivative contract with another non-EU entity (including another UK counterparty) may be subject to requirements under EMIR (including the mandatory clearing obligation, if applicable) where, if that entity were established in the EU, EMIR would apply, and the contract has a “direct, substantial and foreseeable effect” within the EU or to prevent the avoidance of the application of requirements under EMIR. [35]

  1. What are the consequences of Brexit on the phase-in of the initial margin rules under EMIR?

The initial margin rules form part of directly applicable EU legislation and therefore are expected to be incorporated into UK domestic law pursuant to the Withdrawal Bill. However it should be noted that the Withdrawal Bill will only apply directly applicable EU legislation, such as the collateral regulatory technical standards under EMIR, if that legislation is “operative immediately before the exit day” which means that in the case of anything that comes into force at a particular time and is stated to apply from a later time, it is both in force, and applies, immediately before the exit day. Consequently the Withdrawal Bill, if enacted in its present form, would only incorporate into UK domestic law those initial margin requirements that had been phased in prior to the exit day. Initial margin requirements that had not been phased in before the exit day would not be incorporated into UK domestic law via the Withdrawal Bill but, given that the EU margin rules derive from BCBS-IOSCO, the UK is likely to adopt similar provisions.

  1. Will EU entities be able to satisfy the EMIR clearing obligation by using a UK CCP or the EMIR reporting obligation using a UK trade repository?

This depends on the negotiated position and any equivalence decision granted to the UK under EMIR. Articles 25 and 75 of EMIR provide for the European Commission to grant an equivalence decision in respect of third country CCPs and trade repositories, respectively, where the third country’s regulatory regime contains equivalent legal and supervisory arrangements for CCPs/trade repositories to those provided for by EMIR. The European Commission issued a proposal[36] to amend EMIR in order to introduce, amongst other things, further conditions (which, broadly, relate to compliance with prudential requirements and access to information by ESMA) to the grant of recognition in the case of a third-country CCP determined by ESMA to be systemically important (or likely to become so) to the financial stability of the EU or one or more of its member states. Under those proposals, a CCP determined to be of “substantial” systemic importance may, upon the recommendation of ESMA, be refused recognition by the European Commission and instead be required to become established in the EU in order to provide clearing services there. See Question 30 (Will any new arrangements be required to clear derivative transactions in the future?) as to the arrangements that may be required or be desirable if a UK CCP is determined to be of “substantial” systemic importance and is required to become established in the EU in this way.

As the CCP and trade repository provisions of EMIR emanate from international principles published by IOSCO, and are also contained in directly applicable EU legislation, the UK is expected to incorporate EMIR into UK domestic law pursuant to the proposals in the Withdrawal Bill or implement equivalent provisions and so is likely to have objectively equivalent CCP and trade repository rules for the purposes of EMIR[37]. However, the UK will still need a declaration of equivalence to be made by the European Commission. Should an equivalence decision be made, a UK CCP or UK trade repository would be able to make an application to ESMA for recognition under Article 25/Article 77 of EMIR, which would allow EU counterparties to continue clearing and reporting through UK CCPs and trade repositories.

Both obtaining an equivalence decision from the European Commission and CCPs/trade repositories obtaining recognition from ESMA are processes that will take some time – for example, ESMA has 180 working days in which to consider an application for recognition of a third country CCP/trade repository – and it is unclear whether the UK (and UK CCPs) would be permitted to make these applications prior to Brexit taking effect.[38]

  1. Will UK entities be able to satisfy any applicable UK clearing obligation by using an EU based CCP or the EMIR reporting obligation using an EU based trade repository?

This pre-supposes that a clearing obligation is implemented in the UK post-Brexit. This seems to be a reasonable assumption given (i) the proposals in the Withdrawal Bill that directly applicable EU legislation which is operative immediately before the exit day will be incorporated into UK domestic law, and (ii) that the EMIR clearing requirements are aimed at implementation of the G20 commitments on OTC derivatives published by IOSCO in February 2012. Recognition of EU CCPs and trade repositories by the UK will depend on the rules on third country equivalence implemented by the UK, the outcome of the exit negotiations and, potentially, any reciprocal recognition of UK CCPs/trade repositories by the EU.

 

The UK Government has announced[39] that it anticipates that, following the UK’s withdrawal from the EU, UK domestic law requirements for recognition of non-UK CCPs will in essence be the same as the current requirements under Art 25 of EMIR, and that it proposes to give the Bank of England functions equivalent to those carried out by ESMA with respect to CCPs.  The Bank of England has invited third country CCPs recognised by ESMA, who wish to provide services to UK clearing members after the UK leaves the EU, to engage with the Bank for discussions about applying for recognition in the UK[40].

 

The UK Government announcement also states that, if necessary, the UK will provide for a temporary regime to enable the Bank of England to permit non-UK CCPs to continue operating in the UK for a limited period after the UK leaves the EU.

 

In light of the transitional period set out in the Draft Withdrawal Agreement, the Bank of England has announced[41] that non-UK CCPs may plan on the assumption that recognition by the Bank of England will only be required by the end of this transitional period, although such CCPs were encouraged to continue engaging with the Bank of England with respect to the recognition process.

 

  1. Are there any other issues in respect of the clearing obligation that members should consider?

Members of one or more CCPs should review the rules of each of those CCPs to determine whether Brexit is likely to result in them being in breach of those rules. They may also wish to consult with their CCPs in relation to Brexit and its implications, and discuss whether any such potential default might be averted.

  1. Will compliance with UK clearing rules similar to those in EMIR be sufficient as substituted compliance for Dodd-Frank clearing obligations?

 The UK would need to apply to the US and have the UK-based CCP regulations separately recognised as being comparable to rules in the U.S. in order for substituted compliance to be granted. Substituted compliance currently applies to EU-based CCPs that are also registered in the U.S. as a Derivatives Clearing Organization and, as noted above, the UK is likely to adopt broadly similar CCP requirements and related clearing rules by way of the proposals in the Withdrawal Bill. As a result, with rules already deemed comparable (insofar as they emanate from EMIR), the UK ought to be in a position in which it is able to be granted a substituted-compliance determination from the US, but this cannot be guaranteed and achieving such a determination may take time. Clearing through an EU-based CCP would continue to be deemed compliant with the Dodd-Frank clearing obligations.

Collateral 

  1. Are there any consequences of Brexit for parties which have entered into the English law ISDA Credit Support Documents for collateral arrangements which are currently financial collateral arrangements under the Financial Collateral Directive?

The Financial Collateral Directive has been implemented in the UK through the Financial Collateral Arrangements (No 2) Regulations (“FCAR”). This statutory instrument was enacted pursuant to powers in the European Communities Act 1972 (“1972 Act”). Following the repeal of the 1972 Act, the FCAR would be automatically repealed and would need to be re-enacted. If not re-enacted or otherwise preserved, there is an open question as to whether any security interests which would, in the absence of the FCAR, have required registration pursuant to the Companies Act 2006, be void as against a liquidator of a UK company for want of registration. At least initially, it seems that the FCAR will be covered under the provisions of the Withdrawal Bill that preserve existing UK laws that implement EU directives. Although it would be open to UK Parliament thereafter to repeal or amend the FCAR, given the importance of the protections provided to collateral-takers by the FCAR, and the aforementioned risk of invalidity of security interests in the absence of the FCAR, it is likely that these regulations will be retained.

Settlement Finality Directive 

  1. Are there any consequences of Brexit for participants of UK or EEA systems under the Settlement Finality Directive?

The Settlement Finality Directive has been implemented in the UK through The Financial Markets and Insolvency (Settlement Finality) Regulations 1999 (“SFR”). This statutory instrument was enacted pursuant to powers in the European Communities Act 1972 (“1972 Act”). Following the repeal of the 1972 Act, the SFR would be automatically repealed and would need to be re-enacted. However, at least initially, and subject to the powers of the UK government under the Withdrawal Bill to amend “deficiencies” in retained EU law, it seems likely that the SFR will be covered under the provisions of the Withdrawal Bill that preserve existing UK laws that implement EU directives. As a result, English law should continue to recognise systems established in EEA jurisdictions pursuant to the Settlement Finality Directive and the protections given to participants thereunder (including UK-based participants). In contrast, systems established in the UK pursuant to the SFR will, post-Brexit (and absent any agreement on this point as part of the withdrawal), most likely fall outside the scope of the Settlement Finality Directive as implemented in EEA jurisdictions (although this will depend on whether, when implementing the Settlement Finality Directive, the particular EEA jurisdiction has looked to extend recognition to systems established in third countries, which then may capture systems established in the UK). In such circumstances, insolvency courts in those jurisdictions would not be required to recognise the protections under the applicable implementing legislation afforded with respect to systems established in the UK when an insolvent participant is based in their jurisdiction (and could, for example, look to revoke a transfer order in such a system, or prevent the operation of a netting arrangement of a such a system). However, whether those courts could in fact take such action will depend on the position under local insolvency law and whether it provides for those protections outside the implementation of the Settlement Finality Directive. This has implications for EEA-based participants in systems established in the UK – from a practical perspective, those systems may ask for additional comfort from those EEA-based participants regarding the position under the insolvency laws of their local jurisdiction.

Bank Recovery and Resolution Directive 

  1. Post-Brexit, what additional provisions will counterparties need to include in their ISDA Master Agreements to address requirements under the BRRD when facing an EU counterparty?

If, as currently seems likely, the UK does not join the EEA, then it will be a third country for the purposes of the EU Bank Recovery and Resolution Directive (“BRRD”). Pursuant to national rules implementing Article 55 of BRRD, EEA credit institutions and large investment firms must include contractual recognition of bail-in clauses into non-EEA law governed contracts, which post-Brexit will include English law governed ISDA Master Agreements.

Whilst not a requirement stemming from BRRD, certain EEA jurisdictions have also imposed similar requirements regarding contractual recognition of stays for non-EEA law governed contracts. Where the EEA counterparty is located in a jurisdiction which has included such a requirement, that EEA counterparty will also need to include contractual recognition of stays in English law governed ISDA Master Agreements post-Brexit.

 26. Are there any additional provisions which UK entities will need to include in their ISDA Master Agreements when facing an EU counterparty to address requirements under the UK bank recovery and resolution regime (pursuant to the Banking Act 2009 or PRA rules)?

The BRRD has been implemented into the UK through amendments to the UK Banking Act 2009 and is unlikely to be repealed since many of its provisions pre-date BRRD or are broader in scope than the equivalent provisions in BRRD. The UK currently recognises the application of resolution tools and exercise of resolution powers by other EU member states’ resolution authorities (and is restricted from taking its own in respect of non-UK EEA institutions). Once the UK leaves the EU, the mutual recognition of resolution tools by other EEA member states pursuant to BRRD will no longer apply to a UK resolution of a UK bank.

BRRD provides for cooperation agreements with resolution authorities in third countries and a process for recognition, either at an EU level or at member state level, of third country resolution measures, but neither is guaranteed. Consequently, after the UK’s withdrawal from the EU, EEA counterparties to non-English law governed agreements may not be bound to apply UK resolution measures such as contractual stays on enforcement of collateral or exercise of netting rights or application of bail-in to that contract. As a minimum, then, it could be expected that UK entities should look to agree with their EEA counterparties the contractual recognition of stays and bail-in for their non-English law governed contracts. The UK rules currently include requirements for contractual recognition of stays and bail-in in non-EEA law governed contracts. These rules would need to be extended to also cover contractual recognition of stays and bail-in for EEA law governed contracts. In the absence of legislation effecting these changes, however, such additional provisions will be not be mandatory under English law (other than the existing requirement for contractual recognition of stays and bail-in for non-EEA law governed contracts).

27. Is there any impact on the ISDA 2014 Resolution Stay Protocol, ISDA 2015 Universal Resolution Stay Protocol, the ISDA Resolution Stay Jurisdictional Modular Protocol (the “Stay Protocols”), the ISDA 2016 Bail-in Article 55 BRRD Protocol (Dutch, French, German, Irish, Italian, Luxembourg, Spanish, UK entity version) or the ISDA 2017 Bail-in Article 55 BRRD Protocol (Austrian, Belgian, Danish, Swedish entity version) (the “Bail-in Protocols”)?

There is no current impact on those protocols. ISDA will assess, as necessary, the potential application of the Bail-in Protocols and the Stay Protocols to English law governed ISDA Master Agreements in light of the outcome of the exit negotiations.

Amendments to the ISDA Master Agreement and transfers of existing contracts

28. What amendments, if any, should market participants consider making to their ISDA Master Agreement?

  1. None immediately. However, there are amendments which parties may consider making depending on the likely outcome of the exit negotiations. Please see the answers to Question 8 (Inclusion of additional termination rights), Question 9.3 (Choice of law for non-contractual obligations), Question 9.4 (Merits of amending the governing law), Question 11.1 (Insertion of arbitration clauses), Question 13 (Consideration of the jurisdiction clause), Question 14 (Amendments to the jurisdiction clause), Question 16 (Access to the EU financial markets) Questions 25, 26 and 27 (BRRD amendments).

 

29.  Should references in ISDA documentation to EU legislation be updated to contemplate equivalent UK legislation after the UK’s withdrawal from the EU?

It would be helpful at least in some instances for references to EU legislation in ISDA documentation (including protocols) to be updated to contemplate the equivalent UK legislation after the UK’s withdrawal from the EU. It may be that the UK government considers this issue from a more general perspective and the feasibility of this will depend on the progress of the exit negotiations.

 

30. What is the process for transferring derivative transactions from an entity established in the UK to an entity established in the EU?

 Given the loss of EU passporting rights when the UK leaves the EU (see Question 16.1 (EU firms’ ability to carry out derivatives business in the UK)), some UK market participants may be considering transferring some or all of their derivative relationships to EU affiliates or EU branches (although, once the UK is a ‘third country’ post-Brexit, this latter approach would only give access to counterparties in the relevant EU member state in which the branch is located).

Novation: Transferring OTC derivative positions to a different legal entity, albeit in the same group, can be achieved by way of novation. Consistent with Section 7 of the ISDA Master Agreement, a novation will require specific consent to the transfer from the transferor (i.e. the UK entity), the transferee (i.e. the EU affiliate) and the remaining counterparty. A novation can be effected by using the 2002 ISDA Novation Agreement or the 2004 ISDA Novation Definitions, both of which are available on the ISDA website (http://www.isda.org/publications/pdf/NovationAgreement.doc). A payment between the transferee and the transferor will likely be required to reflect the mark-to-market value of the Transaction being transferred. To the extent there is any difference in collateral terms between, on the one hand, the transferor and the remaining party and, on the other hand, the transferee and the remaining party, an additional payment to or from the remaining party may arise. If there is no existing ISDA Master Agreement in place between the transferee and the remaining counterparty, typically a new ISDA Master Agreement will be required. If a Credit Support Annex or other collateral arrangement (e.g. an initial margin arrangement) is in place between the transferor and the remaining party, to the extent that continues to be required, the transferee and the remaining party will need to consider how to effect the transfer of that arrangement smoothly. If the EU affiliate will be used to enter into derivative transactions after Brexit, one advantage of novating existing transactions is that all transactions are able to form part of the same netting set.

Part VII Scheme: For UK authorised persons, an alternative would be to effect a court sanctioned banking business transfer scheme pursuant to Part VII of the Financial Services and Markets Act 2000 (a “Part VII Scheme”). Part VII Schemes are only available where the whole or part of the business to be transferred includes the accepting of deposits and so is not available for the transfer solely of derivative transactions. However, if the derivative trading business forms an integral part of a deposit-taking business and is being transferred along with the deposit-taking business, then a Part VII Scheme may be available. It provides an efficient way of transferring multiple transactions at once without the need for the consent of the counterparties to the transfer.

A Part VII Scheme is available for a transfer to an overseas entity, provided such entity meets the relevant authorisation and capital adequacy requirements for the business being transferred, although recognition of the transfer by the incoming EU member state will also depend on whether the transfer is a valid means of transferring the relevant assets and liabilities pursuant to the laws in the relevant EU member state.

The key conditions to a Part VII Scheme include (a) the UK transferor is authorised to accept deposits by the relevant UK regulator, (b) deposit-taking activities form an integral element of the business being transferred, (c) the transfer must involve the transfer of assets and liabilities, i.e. not a share transfer, (d) the transferee is authorised in the EU member state to carry on the business being transferred (including accepting deposits), and (e) the transferee has sufficient regulatory capital for the risks being transferred. As a practical matter, only agreements governed by English law will transfer automatically under a Part VII Scheme (as well as agreements governed by the laws of a limited number of other jurisdictions which recognise a transfer pursuant to a Part VII Scheme). The Part VII Scheme legislation will also operate to override any rights which become exercisable as a result of the Part VII Scheme (at least to the extent those rights are governed by English law).

The procedure itself involves various steps including regulatory scrutiny, two court hearings with the public having the right to object at the second hearing, and approval by the High Court. However, the length of the procedure should be balanced against the certainty and convenience of the outcome versus individual novations of multiple transactions and the requirement for individual counterparty consent.

Scheme of Arrangement: Other transfer mechanisms, such as a court-sanctioned scheme of arrangement under Part 26 of the Companies Act 2006 (a “Scheme of Arrangement”) may also be considered.

Schemes of Arrangement are used to effect a wide range of transactions, such as the transfer of the whole or part of a business. The key conditions include that (a) the scheme has to be approved at one (or more) meetings convened by the High Court for the purpose of considering the scheme, (b) the scheme has to be approved by a majority in number representing 75% in value of the relevant creditors or shareholders (as applicable) present at such meeting(s), (c) if the necessary voting thresholds are satisfied, the scheme has to be sanctioned by the court and (d) the court order has been delivered to the registrar. The sanction of a Scheme of Arrangement is subject to the exercise by the court of its discretion.

The procedure itself involves various steps. The relevant creditors or shareholders (as applicable) must be sent a notice summoning the creditors’ or shareholders’ meeting, along with an explanatory statement which sets out (amongst other things) the effects of the scheme. The procedure also involves two hearings, and approval by the High Court.

Consideration should be given as to whether the transfer of a derivative could amount to the novation, or entry into, of a new derivative Transaction triggering clearing and collateral requirements (as well as trade reporting requirements) under EMIR.

Cross-border mergers: The Companies (Cross Border Mergers) Regulations 2007 implement in the UK the EU Directive on Cross-Border Mergers of limited liability companies (the “Cross-Border Mergers Directive”). The Cross-Border Mergers Directive has been implemented across the EU and so the regime is effective to merge any company (or companies) incorporated in the UK into a company incorporated in another EU member state.

The effect of the merger is that all the assets and liabilities of the transferor company (including employment contracts) are transferred to the transferee company without the need for counterparty or third party consent. The transferor company ceases to exist on completion of the merger. Shares in the transferee company must be issued in exchange to the shareholders of the transferor company (unless the transferor is already a wholly-owned subsidiary of the transferee). Cash can also be paid as part of the consideration. It is not possible to select only certain assets and liabilities for the merger unless they are first transferred or hived-down to a new UK company which itself is then cross-border merged into the EU incorporated entity (however this initial step may require third party consents for the transfer into the new UK company which may remove one of the principal objectives of the cross-border merger).

The cross-border merger regime is not specific to financial services businesses and so, in contrast to a Part VII Scheme, there are no conditions on the regulatory status of the participating entities and there is no need for deposits to be included in the transferring business. This process also has the advantage of being effective in relation to all the assets and liabilities once approved by the ‘competent authority’ in the jurisdiction of the transferee and so does not carry the risk of a tail of business being left with the transferor. However, the effective transfer of assets and liabilities will not necessarily circumvent the contractual consequences of such transfer and, in contrast to a Part VII Scheme, there is no legislative override of contractual rights which become exercisable as a result of the merger.

Assuming a UK transferor entity, creditors of that entity may apply to the court for a meeting to be convened of the company’s creditors. If the court orders a creditors’ meeting, the merger terms must be approved by a certain majority of creditors. The court will need to be satisfied that creditors will not be adversely affected by the merger if a creditors’ meeting is to be avoided.

In terms of process, pre-merger certificates are required to be issued by the ‘competent authority’ in the jurisdiction of the transferor and transferee (being, in the UK, a court). A joint application is then made to the competent authority of the transferee company for approval of the merger. From finalisation of the cross-border documentation, the process can take several months to complete. An independent expert’s report is required in certain circumstances unless the shareholders of the merging companies agree otherwise.

The Cross-Border Mergers Directive contains extensive provisions regarding ‘employee participation’. Where the surviving entity is not a UK entity, the cross-border merger regime as implemented in the jurisdiction of the transferee will generally govern employee participation. Where the employee participation provisions apply, the process and length of time to implement them are often seen as a deterrent to using the cross-border merger regime.

Societas Europaea: A Societas Europaea (“SE”) is a form of European public limited company established under the EU Societas Europaea Regulation (“EU SE Regulation”). One of the most useful aspects of the EU SE Regulation is that it specifically aims to facilitate the movement of companies across the EU. In principle, it would therefore be possible to relocate the business of a UK public limited company to another EU member state through (a) the conversion of the UK public limited company to a SE under the EU SE Regulation and the associated UK regulations and then (b) the transfer of that SE’s registered office to another EU member state.

An SE can be formed in a number of different ways, including by merging two or more public companies into an SE where at least two of those companies are governed by the laws of different EU member states and also by converting a public limited company into an SE if, for at least two years, it has had a subsidiary company governed by the law of another EU member state.

An SE can only be registered once certain employee participation requirements have been satisfied (i.e. only once there has been a period of negotiation with an employee representative body to agree the basis on which employees will participate in the management/decision making of the SE). The level of employee participation required in the SE depends on the EU member state where the SE is to be registered.

The process of migrating the SE to another EU member state involves notification to shareholders and creditors as well as a directors’ solvency statement to the effect that (a) there are no grounds on which the SE could be found to be unable to pay its debts and (b) that the SE will be able to carry on business as a going concern for the 12 months following the proposed transfer.

It should be noted that it is not possible to complete the conversion process referred to above simultaneously or in parallel with the transfer process referred to above. This means that it would take several months for a UK public limited company to re-register as an SE and subsequently transfer to another EU member state.

To date, not many SEs have been established in the UK or other EU member states (with Germany and the Czech Republic being the exceptions).

31. Will any new arrangements be required to clear derivative transactions in the future?

 To the extent that:

  • clearing of one or more classes of derivatives is no longer permitted in the UK (e.g. euro denominated derivatives (see Question 19 (Will EU entities be able to satisfy the EMIR clearing obligation by using a UK CCP or the EMIR reporting obligation using a UK trade repository?), which refers to recent European Commission proposals in relation to this)) and a clearing member clearing those classes of derivatives in the UK is not a clearing member of an alternative EU based CCP clearing those classes of derivatives,
  • UK based clearing members are no longer permitted to satisfy their clearing obligations at EU CCPs,
  • EU based clearing members are no longer permitted to satisfy their clearing obligations at UK CCPs,
  • EU clients are no longer permitted to use UK clearing members to satisfy their clearing obligations, or
  • UK clients are no longer permitted to use EU clearing members to satisfy their clearing obligations,

repapering may be required as between the relevant affected parties and counterparties. For example, if euro denominated derivatives clearing is prohibited outside the EU, then a clearing member that is not currently a member of an EU clearing house clearing the relevant euro-denominated derivatives may choose to become a clearing member at such CCP, or transfer its business to an EU affiliate that is a member at such CCP. This might involve applications for membership of EU CCPs being made, changes to client clearing documentation (for example, to include clearing at EU CCPs not currently contemplated in the existing client clearing documentation) or entirely new suites of documentation being put in place with affiliated clearing members.

European Benchmark Regulation

32. What is the impact of Brexit on use of an index which is considered to be a benchmark for the purposes of the European Benchmark Regulation?

The European Benchmark Regulation[42] came into force on 30 June 2016 with the main obligations applying from 1 January 2018. The following two obligations will need to be considered in light of the potential impact of Brexit on the continued ability of EU market participants to reference a particular UK benchmark:

  • Where existing derivative transactions reference an index (including an inter-bank offered rate such as LIBOR) that is considered to be a ‘benchmark’ for the purposes of the European Benchmark Regulation, EU supervised entities (which includes certain credit institutions, MiFID II investment firms, UCITS, pension funds and alternative investment funds) will only be permitted to use such benchmark if the benchmark and its administrator appear on the register maintained by ESMA (the “Register”). UK administrators will, post-Brexit, become third country administrators and will have to seek one of the three routes to entry on the register available to such third country administrators: (a) an equivalence determination by the EU Commission, (b) endorsement by an EU authorised/registered administrator or EU supervised entity, or (c) recognition of the third country administrator by the competent authority of the member state of reference.
  • EU supervised entities will also be required to produce and maintain robust written plans on the action they would take in the event that either (a) the benchmark materially changes or ceases to be provided, or (b) the administrator is no longer authorised or admitted to the Register, including the provision of alternatives where feasible and appropriate. This will be particularly relevant for EU market participants referencing benchmarks administered by a UK administrator given the possibility that, as a third country administrator post-Brexit, such administrator may not be admitted to the Register. These fallback plans will need to be reflected in their contractual relationship between the supervised entity and the counterparty.

 

[1]    The Markets in Financial Instruments Directive II – Directive 2014/65/EU

[2]     http://www.parliament.uk/business/publications/written-questions-answers-statements/written-statement/Commons/2017-12-20/HCWS382/

[3]   Regulation 593/2008/EC of the European Parliament and of the Council of 17 June 2008 on the law applicable to contractual obligations (“Rome I”)

[4]  Regulation (EC) No 864/2007 of the European Parliament and of the Council of 11 July 2007 on the law applicable to non-contractual obligations (“Rome II”)

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